As financial advisors gain a deeper level of expertise in tax strategies, they may be increasingly willing to engage in more detailed conversations with their clients. However, if they go too far and cross the line into formal ‘tax advice’, they may face significant liability not just from the IRS but also from their own compliance departments. As such, a clear framework for the types of tax-related recommendations that do not constitute ‘tax advice’ can help advisors to feel more confident in discussing these strategies with their clients.
The broad strokes of a financial advisor’s job description typically include helping clients plan for the future. This includes assisting them with setting up education funds for their children, saving for retirement, growing their small business or buying real estate, and filing taxes for their investment portfolios. A good portion of this work involves finding efficient ways for the client to legally lower their tax liability, compute taxes on complex investment portfolios and find deductions and credits they can claim on their tax returns.
Some strategies that minimize tax liability can involve interpreting the current tax code in a new way. These kinds of interpretations should be left to CPAs and attorneys, or at least done in collaboration with those professionals. But many tax strategies simply make it easier for the client to manage their taxable income. This can be achieved by optimizing the timing or nature of when income is recognized (e.g. Roth conversion strategies) or by making sure that the underlying income is taxed as efficiently as possible (e.g. tax-efficient harvesting of capital gains).
For most advisors, advising on the use of such tax strategies would not violate their compliance department’s rules, provided that they are careful to avoid any interpretation of the existing tax codes or structures that are explicitly designed to shelter income from taxes. But there is a fine line between this and providing advice on the use of structures that have a high potential to abuse the tax code.
The key to avoiding crossing the fine line between tax planning and providing tax advice is recognizing that a strategy needs to be considered, analyzed and formally recommended before it is acted on by a client. This can be as simple as running a hypothetical in financial planning software to compare the effects of different strategies.
It can also be as involved as working closely with the client’s tax professional to develop a specific plan for implementation of the strategy, which then requires the advisor’s final written approval before being presented to the client. This ensures that the strategy isn’t viewed as a tax shelter or other type of practice that only an attorney, CPA or EA can perform and therefore creates unacceptable liabilities for the advisor. By following this 3-step process, advisors can more confidently engage in tax planning with their clients without violating the rules of their compliance departments. Steuerberatung